How to Avoid an Independent Contractor Misclassification Audit

With growing awareness of independent worker rights, high-profile employee misclassification lawsuits, heightened scrutiny from government agencies, and more frequent use of independent contractors, there is an increased risk of being audited for employee misclassification.

Independent contractors, temporary workers, remote workers, and freelancers cannot be engaged or treated like traditional W-2 employees. Doing so risks an audit, which can lead to large fines, bad press, back tax payment, stalled acquisitions, and class-action lawsuits.

Companies of any size and reputation are subject to audits, which can be triggered by a number of activities including a contractor who files for unemployment, a whistleblower who reports possible misclassification, or a worker who files an SS-8 form to request classification determination.

1. Conduct an Internal Audit

Conducting an internal audit can provide you with an in-depth understanding of your current classification practices and whether or not they are compliant. Look for records of services performed by contractors, check to see if you have contracts on file for your independent engagements, and confirm if the contractors you’ve hired in the past have federal tax ID numbers. Are you able to prove that all of the contractors you’ve hired qualify as independent workers? Investigating your practices can help identity gaps and areas for improvement before a regulatory agency steps in with an audit of their own.

2. Create Guidelines for Hiring Independent Workers

Your business may have a worker classification policy in place, but is it followed consistently? If not, you could be at risk. Work with your HR team or hiring managers to develop guidelines for hiring and managing your independent workers. Create policies and plans to ensure these guidelines are enforced across the board, and allow your policy to evolve as needed. Consider possible barriers to implementing these new rules, and develop strategies to overcome obstacles for a smoother adoption process.

3. Make Sure Independent Workers are Properly Classified

The federal government, state government, and government agencies all apply different tests to determine employee classification. These tests lack uniformity, so just because a worker complies with one test, doesn’t mean they’ll comply with another. While this complicates the vetting process, you can still use these tests as guidelines to create a questionnaire or checklist to assess potential workers. If you don’t see issues after your investigation and move forward with hiring, it’s good practice to keep records of your checklist as well as supporting documents like a business or professional license, business cards, or insurance certificates that can be used as proof of self-employment.

4. Have a Written Contract for All Independent Workers You Hire

Having a written contract for all independent workers you hire not only helps to clearly define your working relationship, but it also helps to verify their classification in the event of an audit. In addition to outlining the scope of work, defining the communication process, and specifying payment terms, contracts should include additional safeguards such as explicitly stating the person you’re engaging with is an independent worker, that they are free from control, and that they have insurance.

5. Form a Team to Handle Issues Before They Arise

A cross-functional team keeping an eye out for warning signs can save you a big headache down the road. If possible, include representatives from legal, compliance, HR, and procurement to provide insight and support from different perspectives. This team should be on the lookout for audit triggers such as independent workers filing for worker’s compensation, disability, or unemployment claims as well as ensure that contractor hiring and management processes stay compliant and up-to-date.

While there are many things you can do to minimize the risk of a misclassification audit, independent contractor engagement can be a confusing and tricky road to navigate. Firms like MBO Partners have an established methodology in place for evaluating and engaging independent workers for clients, and have proven best practices for minimizing or eliminating issues with contractor engagement. Partnering with a company that specializes in independent contractor engagement and compliance can help minimize your risk and make sure your business remains compliant.

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